MOSTAFA NOR-EL DIN Macro-Economics Level (1) 7
Chapter two
Macroeconomics Data (An Extended Analysis)
Measuring Economic Activity: Gross Domestic Product (GDP)
is a cornerstone of economic measurement; it is widely regarded as one of the most comprehensive measures
of the overall health and performance of an economy.
attempt to encapsulate all economic activity within a given period and express it as a single monetary figure.
can be viewed in two distinct yet complementary ways:
1) the total income earned by all participants in the economy,
2) the total expenditure on all goods and services produced.
The Equivalence of Income and Expenditure
The dual nature of GDP—as both total income and total expenditure—is a consequence of a fundamental economic
principle: within a given economy, income is equal to expenditure.
As such, each dollar expended by a purchaser directly corresponds to a dollar of income for the seller.
This concept highlights the fact that every economic exchange generates both income and expenditure.
National Income Accounting: A Framework for Measuring GDP
When measured in dollars, GDP can be seen as the total income generated by the production of corn (which is wages
plus profit) or as the total expenditure on the purchase of corn.
The expenditure on goods will always equal the income that comes from producing those goods.
Stocks and Flows
Economic variables are divided into two categories: stock variables and flow variables.
A stock variable is a measurement of a quantity at a specific point in time, and
A flow variable is a measurement of a quantity over a certain period.
GDP is a flow variable. If one says that the U.S. GDP is $20 trillion, this refers to a quantity of
dollars flowing through the economy over a one-year period.
For example,
a household’s wealth is a stock variable, while their income and expenditure are flow variables, which affect
changes in wealth over time.
Similarly, the number of unemployed individuals is a stock, while the number of people losing jobs is a flow.
Rules for Computing GDP
GDP is more than the mere sum of all sales transactions; it is a measure of value added to the economy.
Definition of Gross Domestic Product is ……
the market value of all final goods and services produced within an economy in a given time period.
Rules of how it is calculated:
1) Adding different goods and services together:
In a modern economy with many different types of goods and services, it is necessary to combine these to
create a single measure of GDP.
To do this, economists use the market price as a method of weighing different goods by how consumers value
them.
In this way, a single dollar figure can be calculated which is representative of the overall value of production.
𝑮𝑫𝑷 = (𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔 × 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔) + (𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔 × 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔)
2) Used Goods:
GDP represents newly produced goods and services.
The sale of used goods, like an antique automobile, represents the transfer of an existing asset and therefore
does not reflect new production.
These transactions, therefore, are excluded from the calculation of GDP.
MOSTAFA NOR-EL DIN Macro-Economics Level (1) 8
3) The Treatment of Inventories:
Consider the case of a bakery that produces but does not sell all its bread. If the bread spoils, then it does not impact GDP.
However, if the bakery stores the bread as an inventory, it is treated as a purchase of goods by the owners of
the firm, thus increasing GDP.
When this bread is later sold, it does not increase GDP because it represents a combination of an increase in
spending by consumers and a corresponding decrease in spending by the firms who sell inventory.
This treatment of inventories ensures that GDP reflects the economy’s current level of production.
4) Intermediate Goods and Value Added:
Many goods and services are produced using a multi-stage production process, such as when a rancher sells
meat to a restaurant, which then turns it into food and sells it to a consumer.
GDP only measures the value of final goods.
The value of intermediate goods, like meat, is captured in the price of the final good, the food purchased at the restaurant.
To include both the meat and the final food would lead to double counting.
Another way to look at GDP is as the total value added across all firms in the economy.
A firm’s value added is simply the value of the firm’s output minus the value of inputs it purchased from other firms.
5) Housing Services and Other Imputations:
When measuring GDP, it is necessary to consider goods and services that may not have a traditional market price.
Economists measure these non-market transactions by using imputed values.
Housing is one such example. People who rent homes purchase a service for which there is a clear market price.
However, it is also necessary to include the housing services of people who own their own homes.
To do this, national accounting includes an estimate of what their rental income would be.
In addition, imputed values are also used for government services, which are valued at the cost of providing those
services (i.e., the wages paid to government workers).
There are many cases where imputed values are not used, however, for the sake of simplicity.
For example, estimates of the value of household chores or the underground economy are not included in GDP.
Real GDP vs. Nominal GDP
GDP can increase either from an increase in the quantity of goods and services produced or from an increase in prices.
Economists distinguish between these two by using real and nominal GDP.
Nominal GDP is the total value of goods and services produced at current prices.
Real GDP is measured using constant prices, which isolates changes in production from changes in prices.
To calculate Real GDP, one uses a set of base-year prices and calculates GDP using those prices for all years.
In this way, changes in GDP are exclusively the result of changes in production.
This method allows economists to compare output over time, making it a superior method for gauging
changes in the standard of living. Real GDP for 2020 would be:
𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 = (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔 × 𝟐𝟎𝟐𝟎 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔) + (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔 × 𝟐𝟎𝟐𝟎 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔)
Similarly, the real GDP in 2021 would be:
𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 = (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔 × 𝟐𝟎𝟐𝟏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔) + (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔 × 𝟐𝟎𝟐𝟏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔)
And the real GDP in 2022 would be
𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 = (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔 × 𝟐𝟎𝟐𝟐 𝑸𝒖𝒂𝒏𝒕𝒊t𝒚 𝒐𝒇 𝑨𝒑𝒑𝒍𝒆𝒔) + (𝟐𝟎𝟐𝟎 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔 × 𝟐𝟎𝟐𝟐 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒐𝒇 𝑶𝒓𝒂𝒏𝒈𝒆𝒔)
The GDP Deflator
The GDP deflator, also called the implicit price deflator, is another measure of the price level in the economy.
This metric is derived from the ratio of nominal GDP to real GDP.
The deflator reflects the overall level of prices in the economy and serves to separate the impact of changes in
quantities from changes in prices in the computation of GDP.
𝑮𝑫𝑷 𝑫𝒆𝒇𝒍𝒂𝒕𝒐𝒓 = 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷 ÷ 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷
Using this relationship, real GDP can be thought of as nominal GDP, with the effect of inflation “deflated” out.
𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 = 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷 ÷ 𝑮𝑫𝑷 𝑫𝒆𝒇𝒍𝒂𝒕𝒐𝒓
Accordingly, this definition of the GDP deflator allows us to split nominal GDP into two parts: the first part measures
quantities (the real GDP) and the second part measures the prices (the GDP deflator).
